DEFINITION of ‘Fence’
A risk-mitigating investment strategy that utilizes options to limit the possible range of returns. To employ a fence, the investor purchases a security (a long position), a long put with a strike price near the spot price of the security, a short put with a strike price lower than the spot price of the security and a short call with a strike price higher than the spot price of the security. The options are typically set to expire at the same time. The option premiums should balance each other, having a net derivative investment of zero while the underlying security is bought.
BREAKING DOWN ‘Fence’
A fence is used to limit the movement of an option investment return, just as a fence used on a farm is designed to keep animals from wandering outside of a property. An investor may employ a fence if the underlying security has increased in value, since employing a fence will reduce the risk of loss. When the options employed expire, the strategy is designed to keep the value of the investment between the strike prices of the short call and long put.